Have you ever been faced with a significant unexpected expense? Like an unplanned but major home repair? Or a major overhaul to your car after a minor accident? Or worse, a financial crisis following the demise of a primary earning member in the family? In situations like this, you may have to shell out a major part of your savings to meet the financial needs arising out of such emergencies. 

This can prove to be a major setback to your financial goals, and you may face a delay, or find it altogether impossible to meet some of your expected financial targets. Here is where insurance can help. But what is insurance? And how does it work? Let’s find out the answers to all these questions that cover the basics of insurance. 

What is insurance?

Insurance is a legal contract between an insurance provider (or insurer) and the insured person. As per this contract, the insurance provider agrees to compensate the insured person or their nominee, upon the occurrence of the insured incident or contingency. This incident can be any event that causes a loss to the insured person or their nominee, such as the demise of the insured person, any damage to their property or vehicle, any medical emergency and so on. So, this sums up the definition of insurance. 

Since the incidents outlined above tend to have a certain level of uncertainty attached with them, it is impossible to have a precise financial plan in place to tackle these needs. This is why it is essential to have an insurance policy in place to cover the financial contingency associated with such events. 

How does insurance work?

There are many different types of insurance, as you’ll see in one of the sections below. And the finer details of how insurance works may vary from one type of insurance plan to another. But broadly speaking, here is how an insurance cover works. 

• When the insured and the insured enter into a legal contract, the insurance policy outlines the exact events that are included under the cover as well as the incidents that are specifically excluded. 
• The insurance provider offers a specified sum as the financial compensation or cover in case of each of the insured contingencies. 
• The cover is valid for a specified period, as mentioned in the policy. 
• In case any of the insured events come to pass during the period over which the policy is active, the insurance provider pays out the financial benefits as specified in the terms and conditions of the policy. 
• These payouts can help the insured person pay for the financial contingencies, as needed.
• In return for this financial cushion, the policyholder must pay a sum of money as compensation to the insurer periodically, over the duration of the policy. This sum is known as the insurance premium. 
• In case the insured person fails to pay the premium as per the policy’s terms and conditions, the insurance cover lapses. 

What are the different types of insurance?

Insurance can broadly be categorized into two types - namely life insurance and general insurance. Life insurance offers financial protection in case of the demise of the insured person. In other words, it covers the life risk associated with the insured party. General insurance covers non-life risks, such as the risk associated with loss or damage to property, medical emergencies or illnesses, travel-related contingencies and so on. 

Depending on the kind of non-life risk covered, there are different types of insurance such as:

• Health insurance
• Motor insurance
• Home insurance
• Travel insurance
• Commercial insurance 

What are the key components of an insurance policy?

Now that you know the basics of insurance and how it works, let’s take a look at the key components that are common to most (or all) insurance policies. 

• Insurance premium

The insurance premium, as you saw above, is the sum of money that the insured person or the policyholder needs to pay the insurer for the financial cover offered. This insurance premium may be paid as a one-time lump sum amount or as monthly, quarterly, semi-annual or annual payments. 

• Policy term

The policy term is the period over which the cover offered by the insurance policy is valid. Only if the insured incident occurs during the policy term will it be covered by the insurance plan. 

• Sum assured

The sum assured is the amount that the insurer will pay the insured person or their nominee in case the insured contingency comes to pass. 

• Deductible

This is specific to some kinds of general insurance. It is a specified amount or percentage of the liability that the insured person or the policyholder must pay out of pocket, before the insurer settles the rest of the claim. 

• Claim

A claim is a formal request that the insured person or their nominee makes to the insurance provider, asking for the financial payouts due upon occurrence of the insured event.

Wrapping up

This sums up the basics of insurance. Up next, we will take a closer look at the biggest name in the life insurance sector of India - the Life Insurance Corporation (LIC). Want to know all about this insurance giant? Head to the next chapter for the details. 

A quick recap

• Insurance is a legal contract between an insurance provider (or insurer) and the insured person. 
• As per this contract, the insurance provider agrees to compensate the insured person or their nominee, upon the occurrence of the insured incident or contingency. 
• Insurance can broadly be categorized into two types - namely life insurance and general insurance. Life insurance offers financial protection in case of the demise of the insured person. 
• General insurance covers non-life risks.